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Our Chancellor would like to regulate banks even more and suggests that all liabilities should be on their balance sheets. We dealt with the background to this in our recent article in the Independent on Sunday. We discussed derivatives in the global economy. Derivatives have been at the core of the easy credit cycle but the liability side, especially the hidden risks in notional principal values, has largely been ignored. Any benefit to economic prosperity has an equivalent cost.
Normal securities trading is subject to both price reporting - so that everyone knows the market price - and trade reporting - so that regulators know who has bought or sold what. Credit derivatives held by banks are outside these rules, enabling each bank to set its own valuations, leaving us all in the dark as to real risks.
The risks are significant, since all the conditions for a stock market upset are now in place. The credit supply is constrained and both business and property markets are slowing down. Stock markets have rallied from the August lows to levels that bear no relation to economic prospects. They will soon turn down.
Whether there is a crash or merely a series of declines punctuated by rallies, is immaterial. A crash is just the proverbial bolt from the blue, stimulated by a stray unpredictable news item. Trouble may originate on Wall Street or even in China: global markets are totally interconnected.
It is indisputable that the 20 year interlude created by Alan Greenspan's easy money is now drawing to a close. The simple answer from 1987, further helpings of easy credit, is no longer available. So don't be surprised when the trends change and derivatives come into the headlines.
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